Brokerages have changed significantly over the past 20 years. Aspiring traders with small accounts now can participate with much smaller accounts than in the past.

When first thinking about trading, most if not all traders start with stocks. However, the cost of buying shares to trade can quickly use all of the cash in a small account. I consider a small trading account as one of $5000 or less. There are a vast number of interested traders with accounts of $500 or less.

These traders quickly find out that they have to trade leveraged assets to have an ability to trade at all. This pushes them into assets like futures, forex, and options. You can learn to use options with a small account and limit risk in trades.

Many changes have taken place that has made trading options less costly, including free. There are now ways to limit risk that make it very easy to start trading with accounts of less than $1000.

These are a few of the most significant changes that have helped change the playing field for the retail investor.

Commissions

In the past, the typical brokerage would charge an options trader a ticket charge (minimum) per trade PLUS a fee per options contract. While this is still a widespread practice, most if not all brokers offer commissions based on a per option charge only. If you are paying a ticket charge, you should call your broker immediately and change to per option only.

Paying over $1 per option is too high.

Tastyworks offers a commission structure where you only pay to put on a trade and not to close it out, which can save you even more money over time.

Robinhood is an online broker offering no commissions to trade. Their trading platform is terrible. You need to spend some time learning it, but you can trade and not pay any commissions to do so.

As of this writing, I opened an account and funded it with $100 and am making trades. The bottom line is that commissions should no longer be a hurdle in getting started trading since there is no cost to overcome if you use a broker like Robinhood.

Strike Widths

One of the basic strategies options traders learn and begin with is credit spreads. These are high probability trades that are out of the money.

When I first started trading spreads, the strikes were 5 points apart. This meant that I would need $500 per trade minus my credit to trade one spread. Even in a $5000 account, you can't trade many of these every month as each trade would take up 10% of the account value.

Today there are many stocks with strike widths of 2.50, 1.00, and even .50. The margin needed for an options spread with 0.50 strike separation is $50 minus the credit you received. You can see how this would make trading and risk much easier when you are going into a trade with $50 vs. $500. It is a huge advantage for traders today.

Weekly Options

When I started trading back around 2000, I could only trade options that expired every 30 days. This limited the amount of turnover or trades I could make. You can open and close trades within that period as much as you want, but it does limit the choices you have.

Today, a large percentage of stocks and indexes have weekly options that provide more bang for the buck in the shorter expirations due to how Theta decays. If you don’t like one option contract that is expiring soon, you can look to the next weekly out in time or the next. The choices are much bigger today providing opportunities that just didn’t exist with only monthly expirations.

Putting is all together – A comparison of two spreads

The old: Commission of $6.95 per trade plus $1.50 per option.

5 dollar WIDE SPREAD WOULD COST $13.90 + $6 = $19.90 to enter and exit a trade plus $500 of margin. The cost alone is 4% of the margin that would have to be over come by profits. The new: Zero Commissions

One typically overlooked advantage of small width spreads is that the ROI tends to be better the smaller the width is versus trading wider spreads. This isn’t always the case but typically holds true and is worth investigating.

]]>https://aeromir.com/00789/improvements-for-traders-with-small-accounts/feed1Using Options For Swing Tradinghttps://aeromir.com/00562/using-options-for-swing-trading
https://aeromir.com/00562/using-options-for-swing-trading#respondSun, 02 Jun 2019 01:08:37 +0000https://aeromir.com/?p=562Steve Spencer at SMB posted a video of how to use options for swing trading. Steve used a synthetic stock position with a split strike, done for a credit. The video was posted at https://www.youtube.com/watch?v=nMq1TZFBToE

Is that the best trade we can put on?

Steve's trade uses $26,000 of margin. In the video, Steve says he received a $4 credit but it was really only $2.60. On 10-contracts, that's a +$2,600 potential profit. Here is what the trade looks like visually:

How about using a vertical spread?

One problem with Steve's idea is that he is buying a call after the stock price has fallen. This usually means that volatility has increased.

As the stock rises, you are making money with the short put but your call is fighting decreasing volatility. Delta is helping the call of course, but why not use a vertical to minimize the effect of Vega on the trade?

To have roughly the same Delta of the position, I did a 14-lot short put spread (a put credit spread). Recall that a short put spread is identical to a long call spread. This spread has the same +$2,600 potential if the stock sits as Steve's trade:

Here's how Steve's trade and this one compare:

The two trades have roughly the same profit potential if the stock expires above 185 and below 215.

Steve's trade has about $170,000 of risk if TSLA goes to $10. It can happen. Remember Enron? My trade has $11,400 of defined risk on the down side.

Steve adjusted with the stock $10 higher than his entry. Let's do that with the vertical spread.

Vertical spread adjustment.

We have many possible adjustments. Here are three choices:

We could buy the 200/185 Put spread for $2.65. This creates a split strike butterfly with the maximum risk reduced to $1,100 (up or down) and a max profit potential of $12,870. Expected return three days before expiration is +$1,449.

We can buy the 195/185 Put spread for $2.01. This creates a butterfly with a maximum risk of $266 and a maximum profit potential of $13,780. Expected return three days before expiration is +$1,249.

We can buy the 190/180 Put spread for $1.49. This creates a narrow condor with a $460 credit. We are playing with house money at this point! Expected return three days before expiration is +$1,107.

We can get creative and buy 10 200/190 Put spreads to create a broken wing butterfly with no risk on the upside but -$4,086 risk on the downside. Expected return three days before expiration is +$1,711.

Option 3 looks like this:

We Can't Lose!

You can't lose on this trade now. While you could take the trade off, you have some nice profit potential if the stock moves lower. The only risk is giving up some of the unrealized profit.

Would you like to put a trade like this on for a $500 credit? I would.

End Result.

TSLA stock closed at 185.16 on May 31st. Steve's trade would have made a +$2,600 profit. With the market falling, the option #3 I show above, made about +$7,000. If you had gone with option #1, the $15-wide put spread you bought for $2.65 expired at $14.84, which is over a +$12,000 profit!

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

New Trade Alert service based on this trading style.

This style of trading of putting a directional trade on and spreading off the risk will be a new trade alert service soon. If you'd like to be on the list to get our free charter trial, please sign up at https://aeromir.com/tas

Do you use options to take directional trades? What type of trades do you do?

Scott from StratagemTrade.com presented the Rolling Thunder trade which is used during fast markets to hedge a portfolio of long Deltas or to take a directional opinion. Scott reviewed how the trade works and covered an example with a discussion of different ways to manage and adjust the trade. There was a good Q&A session at the end of the webinar.

]]>https://aeromir.com/00299/rolling-thunder/feed0Weekly Options – Be Aware Of The Riskshttps://aeromir.com/00176/weekly-options-be-aware-of-the-risks
https://aeromir.com/00176/weekly-options-be-aware-of-the-risks#respondSun, 05 Aug 2018 18:59:02 +0000https://aeromir.com/?p=176Options trading becomes more and more popular every year. The options become more liquid and more traders use them for hedging, speculation, income etc. Weekly options (weeklys), introduced by CBOE in October 2005, are one-week options as opposed to traditional options that have a lifespan of months or years before expiration.

There are hundreds of options trading “gurus” promising you all kinds of ridiculous returns like “5% per week” or “10% per month”. What most traders don't realize are the risks that come with those returns.

What are Weekly Options?

As a reminder, options expire on the third Friday of every month. Weekly options, first introduced by CBOE in October 2005, are one-week options as opposed to traditional options that have a life of months or years before expiration. New series for Weekly options are listed each Thursday and expire the following Friday. In fact, many stocks now have weekly options going as far as 5 weeks.

Not every stock or index has weekly options. For those that do, it means that every Friday is an expiration Friday. That opens tremendous new opportunities but also introduces new risks which can be much higher than “traditional” monthly options.

Make 10% Per Week with Weeklys?

Question from a reader: What about selling the weeklies? The timeframe is very short and if you are more conservative, you can skip the weekends and start the trade on Monday and bet on about 4 days. You can still get about 10% return per week with very little risk.
To earn 10%, you must allow the options to expire worthless. That involves much more risk because each day comes with the tiny possibility of market-moving news.
If you can earn 10% per week and compound those earnings, after one year, $1,000 would become $142,000. I’m sure you cannot expect to win every week, but I hope that you recognize that it is impossible to earn such reruns with low risk.

I believe that your plan is fine for the experienced, disciplined trader who is skilled at managing risk. However, it is far too dangerous for the novice trader.

Be Aware of the Negative Gamma

Many options “gurus” ride the wave of the weekly options and describe selling of weekly options as a cash machine. They say that “It brings money into my clients account weekly. Every Sunday my clients access their accounts and see + + +.” They advise selling weekly credit spreads and present it as a “a safe option strategy because we’re combining an option purchase with an option sale resulting with a credit into your account”. What is the biggest issue with selling weekly options? The answer is the negative gamma.

The gamma is a measure of the rate of change of the delta. The gamma of an option is expressed as a percentage and reflects the change in the delta in response to a one point movement of the underlying stock price. For options buyers, the gamma is your friend. For options sellers, the gamma is your enemy.

Selling weekly options will give you larger theta per day. But there is a catch. Less time to expiration equals larger negative gamma. That means that a sharp move of the underlying will cause much larger loss. So if the underlying doesn't move, then theta will kick off and you will just earn money with every passing day. But if it does move, the loss will become very large very quickly. Another disadvantage of close expiration is that in order to get decent credit, you will have to choose strikes much closer to the underlying.

Common Mistakes

Here are some mistakes that novice traders do when trading Iron Condors and/or credit spreads:
• Opening the trades too close to expiration. There is nothing wrong with trading weekly Iron Condors – as long as you understand the risks and handle those trades as speculative trades with very small allocation.
• Holding the trades till expiration. The gamma risk is just too high.
• Allocating too much capital to weekly options.
• Trying to leg in to the trade and time the market. It might work for some time, but if the market goes against you, the loss can be significant and there is no another side of the condor to offset the loss.

Does it mean you should not trade weekly options? Not at all. They can still bring nice gains and diversification to your options portfolio. But you should treat them as speculative trades, and allocate the funds accordingly. Many options “gurus” describe those weekly trades as “conservative” strategy. Nothing can be further from the truth.

Dan made a few statements that I need to comment on:
– Dan says that he sells in-the-money calls if he is bearish. Why would you sell ANY covered calls if you are bearish? Covered calls are a bullish strategy. Since Dan only goes out 30-days, he doesn't give his bearish outlook much time to change to a bullish trend.
– Why would someone do this? Dan's answer is extra income. A better answer is to reduce volatility of your returns, which will improve your returns in the long run. Income is nice if the stock stays in a range of course, but the reduction in the volatility of your returns is the most important benefit in my opinion.
– What's the problem with this trade? Dan says cost.

In Dan's example, the return for one month is $100 on $8900 of margin required, or +1.12% in one month. That is +13.5% per year.

Dan says that replacing the long stock with a long call ( +1 Feb 2019 75 Call for @ 18.00 ) has a higher yield. It does have a higher yield but that's not the whole story.

The real question is how much risk are you subjecting your account to?

Let's assume you had a $10,000 account and could put one covered call trade on. You could afford to put several diagonals on but you would be over leveraging your account.

Yes you'll make a lot more if the stock goes your way; however, you'll lose a lot more if the stock moves against you.

Let's assume you want to keep the risk profiles similar.

The yield on the entire account is the same but the margin used is not. Dan can't claim that the diagonal is better because it has a higher yield. The yield on the account should be the same if you are trying to generate a $100 profit from either strategy.

What are you going to do with the extra cash?

Most people will put more trades on, either in XYZ or in something else.

Doing this will over leverage the account.

Let's see how.

In a $10,000 account, you could put five $1700 trades on for $8500 of margin used. (Pretty close to the margin from the covered call).

Let's say the stock either makes or loses $100 for each trade.

The covered call with either gain or lose 1.12%

The diagonal will gain or lose $500, or 5%

Let's say the market had a strong sell off

The covered call lost $300, or -3% of the entire account.

The diagonal would lose $1500, or -15% of the entire account.

If you lost -3% of your account, you need to earn +3.1% to get back to break even.

If you lose -15% of your account, you need to earn +17.6% to get back to break even!

Now assume the market really crashed and the covered call lost -$1000, or -10% for the entire account. You need to make +11.1% to get back to break even.

The diagonal will lose -$5000, or -50% of the account. You need to make a 100% return just to get back to break even!

You can see how over leveraging becomes a catastrophic event for your portfolio.

Other considerations

Stock has +100 Delta. Dan's deep-in-the-money call might have a +85 Delta. If the stock is moving higher, the covered call will be making money faster.

On the flip side, if the stock is moving down, the covered will be losing money faster.

If you own the stock, you can collect dividends which may have favorable tax treatment if held over 60-days for common stock and 90-days for preferred stock.

Stock has the ability to put married puts to absolutely limit risk. Dan Harvey and I prefer this method over covered calls or diagonals.

In Summary

Selling a covered call is very similar to a diagonal; however, the diagonal has the temptation to over leverage your account. Over time, this will hurt your performance as losses are magnified and time to recover from the losses will increase. If you are bearish on a stock, DO NOT SELL COVERED CALLS! They are a bullish strategy.

Dan Harvey is a well known options trader who specialized in Iron Condor trading for many years. Dan had an article published about him in SFO magazine in 2008. Over time, Dan noticed several problems with Iron Condors so he modified them to address their shortcomings. The new version was a weird looking Iron Condor so Dan called it a Weirdor.

Dan is a great trader and doesn't stick to one type of trade. Dan also likes to trade butterfly spreads. Butterflies collect a lot of time premium and can be adjusted many ways. As Dan traded his butterfly positions, he would eventually have a profitable position and wanted to protect this profit. This is important because doing nothing with a profitable butterfly has risks:

It becomes more sensitive to large price changes

Gamma increases exponentially over time

Delta is less reliable due to Gamma

The T+0 profit/loss line (today) progressively gets less flat over time as you can see:

What Happens to a Butterfly As It Makes Money?

The wings are losing value quickly. The more value they lose, the less they are hedging the position. The wings provide positive gamma to keep the T+0 flat by offsetting the negative gamma from the short options in the center of the butterfly. This causes the T+0 line to become progressively more curved.

The Story

Dan Harvey was talking to Mark Sebastian (now at optionpit.com) one day. Dan showed Mark how he was buying back the short center options and selling options farther from the center to create an iron condor shaped trade. This had the effect of flattening his T+0 line since there was less negative gamma. Here's what a typical adjustment would look like:

This adjustment has several benefits:

Margin is reduced

Option Greeks are reduced

The T+0 line is smoothed, which also widens the break even prices

Mark Sebastian liked the adjustment, but he doesn't like buying expensive options back, so he proposed doing the reverse of what Dan was doing. Instead of rolling the short center options out, roll the long wings in. This is the reverse of what Dan Harvey was doing so Mark called it a “Reverse Harvey” and the name has stuck every since.

What Is A Reverse Harvey?

It is simply a technique of rolling long wings in closer to the money. Here is an example:

What Happened?

The margin was reduced over 50%

The option Greeks are reduced

The T+0 line is flattened and smoothed, widening the expiration break even prices

Most of the profit potential is retained

DOWNSIDE: Theta is temporarily reduced

Can You Use a Reverse Harvey In Other Trades?

Of course! Just about any spread can use this idea of rolling long wings in to cut margin, flatten the T+0 line and widen your break even prices. This includes butterflies, iron condors, weirdors/jeeps, vertical spreads and more.

Summary

The Reverse Harvey is a standard adjustment technique all option traders should be familiar with. It's easy to do and has many benefits.

Have you used the Reverse Harvey technique? Tell us how you like the technique in the comments below.